Make sure your portfolio profits in losing markets

Alternative mutual funds and ETFs are key to risk management

SAN FRANCISCO (MarketWatch) -- With the U.S. stock market in May sliding to its biggest monthly drop in more than a year, the bears are back. Is your portfolio prepared?

The easiest way to withstand a market downturn, of course, is to keep any money needed within five years out of stocks and in short-term bonds or bank CDs. The harder part is leaving the rest of your nest egg to weather the storm.

At such wrenching times, it helps to have stock investments that either run counter to the downtrend or at least don't lose as much. If the 2008 market meltdown taught us anything, it's that non-traditional mutual funds and exchange-traded funds designed to act as a buffer when stocks slide have a place in an individual's investment portfolio.

The trend may be your friend, as they say on Wall Street, but nowadays the trends are shorter and twisting, making it all too easy for individual investors to get whipsawed and challenging their resolve.

"A lot of investors developed their habits in a long-term bull market. In that kind of market, every drop was succeeded by a new high, so you're more focused on maximizing the uptrends," Kays said. "In a long-term sideways market, risk management and preserving capital becomes more important."

Investments that act independently of the broad stock market can be valuable additions to a portfolio. You don't need to commit much -- 10% of assets is a baseline or 20% tops. Be aware that these hedging products are frequently more expensive than a typical fund or ETF, but you're paying a premium for insurance and the specialized role they play.

With that in mind, here are three categories to consider:

1. Bear-market funds

Bear-market products are designed to make money when stocks decline. Many of these funds and ETFs use leverage to boost returns, but leverage can work against you and is best avoided. You're better off with straightforward, unleveraged products that use short-selling as the cornerstone of a bearish strategy.

Bear-market funds did their job in the market's recent correction. These investments gained almost 11% on average in the four weeks through May 27, while funds that track the Standard & Poor's 500-stock index
SPX, -0.23%
tumbled around 9%, according to fund-researcher Lipper Inc.

Veterans of the bear-fund camp include Federated Prudent Bear Fund
BEARX, +0.47%
which is up about 5% in the past month, and Grizzly Short Fund
GRZZX, +0.00%
up about 7% in the same period.

An interesting choice could be an offering from bond-fund giant Pimco that's run by famed manager Bill Gross: StocksPLUS TR Short Strategy Fund
PSSAX, +0.45%

Its sophisticated approach involves shorting the S&P 500 and investing the proceeds in intermediate- and short-term bonds for income. The fund added about 7% in the past four weeks, but unlike most of its bear-market category peers, it's also up for the year so far.

On the ETF side, unleveraged short-selling options include ProShares Short Dow 30
DOG, +0.33%
ProShares Short QQQ
PSQ, +0.13%
which is tied to the Nasdaq 100 Index, and ProShares Short S&P500
SH, +0.10%

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